KEY POINTS:
What a way for China to start 2007. After surging 30 per cent since November alone, the stock market continues to soar to its highest levels since 2002.
Such has been the performance of China's two domestic stock markets that it has triggered a virtuous cycle: as the
key indices march upwards, they attract increasingly good companies, who can sell off equity at an attractively high price.
The cream of China's corporate sector has historically had to list in Hong Kong, but they are now taking a second look at listing on their home bourses. This will finally rectify the absurd situation where Chinese investors were barred from buying their own blue chips.
Some observers are also saying that the mismatch between a picture-perfect macro performance and a lamentable stock market showing is coming to end.
Recall that what baffled foreign investors, desperate to ride the coat-tails of China's 9 per cent annual growth, was the fact that there were no companies to invest in.
That was for two reasons. Capital account controls protected the currency against speculation, meaning that foreign equity capital was stopped at the border. Secondly, foreign investors tended to look at listed Chinese companies and either move swiftly back towards the nearest airport or opt for some foreign direct investment instead.
Listed companies were indeed diabolical - essentially just a way for provincial governments to raise money from Chinese retail investors for companies they were tired of subsidising through bank loans. Yes, that's right - provincial governments were listing their worst companies.
For a long time the ploy worked. Investors with very few other options poured their money indiscriminately into the government-backed stock market - until they were spooked in 2003 by government plans to "reform" the markets.
Chinese investors were not stupid. Although it sounds paradoxical that they would exit the market once the government announced its intention to make the market more efficient, it is actually not. Investors knew that the companies they invested in were rubbish, and that efforts to clean up the market would cause many counters to tank.
Over the course of 2006, the government pressed ahead with reforms, in the face of bitter resistance from the lobby groups and industry elements who were quite happy with corrupt markets that they could easily bend to their will.
The essence of the government's reforms was to unify the two classes of shares which existed previously. Indeed, in the old days, government-appointed managers could carry on as incompetently as they liked - because their controlling stake was assured by the fact that government-held shares could not be bought or sold (the government shares far outnumbered the tiny number of liquid shares, which was all that was available to local investors).
Now, that has all changed. With the two share classes unified, government managers know that the previously untradable shares are open to the threat of mergers or acquisitions. The government's reforms have signalled to company managers that ownership is now open to negotiation.
Needless to say, I've missed out on the bonanza. At the beginning of the year, I gave a speech at a Korean conference on investing in China and pontificated about the dreadful state of the Chinese markets, its regulators, and its listed stocks.
Following me were car-salesmen type fund managers from the US and the UK urging Korean investors to pour their last won into the Chinese market through specially designed and very expensive funds. Typical of the level of discourse was the "fact" proclaimed by one American that countries hosting the Olympics invariably saw their stock markets soar.
Yet they were right, and I was wrong. Somehow they had sniffed the wind and divined which way it was blowing. In contrast, while my analysis was generally right, it had failed to grasp the spirit of the times.
How can my analysis have been right? Well, despite the reforms, the stock markets are still facing a host of problems. When companies list, for example, the process is micro-managed by the government - even to the price to earnings ratio at which the company sells its stock. Even more fundamentally, the government decides when and which company can access the market.
So unlike in Hong Kong, the mainland investing public has little say in which company it can invest in - everything is decided by the government. In such an environment, it is far more likely that any opportunities for takeovers will also be determined by the government rather than the market.
Here is further evidence that not all that much has changed. There had been no widespread delisting of companies. The rubbish companies which were listed years ago are still there. Nor has management changed - they, often government-appointed incompetents, are still in control.
One of my neighbours invests in the stock market. She works in real estate. She does not have a clue about the companies she invests in - she chooses the companies according to whether their stock codes are "lucky". Of course, there are an increasing number of relatively professional institutional investors, such as insurance companies and pension funds, but sentiment in emerging market stock market is often set by the volatile and trigger-happy retail segment.
So who knows - perhaps by the end of the year, my analysis will gets its revenge over the salesmen who have been so annoyingly on the money so far. After all, while markets can go up, and stay up, for a long time for no fundamental reason, they can't defy the rules of gravity for ever.
